In the midst of optimism surrounding the possibility of a soft landing for the economy, a Deutsche Bank economist warns that the danger of a recession has not passed. Jim Reid, the bank’s head of global economics, argues that such optimism is common before an economic downturn. While many point to a strong labor market and positive economic indicators as evidence of a soft landing, Reid cautions that history provides ample reason for caution.
The Bull Case: A Strong Labor Market
One of the key factors fueling the discourse of a soft landing is the strength of the labor market. The U.S. Labor Department’s report of 216,000 new jobs in December and a steady unemployment rate of 3.7% have contributed to this narrative. Europe has also experienced a similarly robust labor market. Reid, however, acknowledges that this positive trend is not enough to dismiss the possibility of a recession.
While the bull case is certainly compelling, Reid points to gathering storm clouds on the horizon. One important aspect is the time lag associated with interest rate hikes. The recent hike in late July suggests that it is still relatively early in the cycle, which historically takes 19 to 28 months to fully unfold. According to Reid, a recession before the start of Q4 2023 would be considered historically early and poses higher risks compared to previous years.
Reid emphasizes the significance of yield curve inversions in predicting recessions. Historically, yield curve inversions have accurately foreshadowed economic downturns. Additionally, credit conditions are tightening, which can have adverse effects on consumer spending and sectors like commercial real estate. These factors further contribute to the cautious outlook on the economy.
Despite the concerns raised, the economy has managed to defy expectations. The Atlanta Fed’s GDPNow tracker indicates a projected 2.5% annualized gain in fourth-quarter GDP, highlighting a positive trend. The New York Fed’s 12-month recession probability gauge, which measures the spread between 3-month and 10-year Treasury notes, has also declined to 63%, although it remains relatively high. Even Deutsche Bank’s U.S. economics team recently expressed optimism about a soft landing, highlighting the potential impact of expected Fed rate cuts in mitigating economic sluggishness.
A Historical Lens: Avoiding Complacency
Reid, however, cautions against complacency by looking at historical tightening cycles and economic trends. While the current data may support the notion of a soft landing, it is crucial to recognize that this stage of the cycle typically exhibits such characteristics. Therefore, it is imperative not to overlook the historical risks associated with a recession.
As discussions about the likelihood of an economic recession continue, it is essential to critically assess the optimism surrounding a soft landing. While positive indicators, such as a strong labor market, provide reasons for optimism, it is equally vital to acknowledge the potential risks. Yield curve inversions, tightening credit conditions, and the historical timing of interest rate hikes should not be dismissed. By adopting a critical perspective and learning from history, we can better navigate the uncertainties of the economic landscape and make informed decisions to safeguard against the potential impact of a recession.